Editorial Commentary

Don't Save the Whales

Bring back the original Volcker Rule: what the former Fed chairman did in the 1980s. He let the markets set interest rates, which sparked a recession. But the move then started a 30-year bull market in bonds.

Thank You

Error.

The Volcker Rule isn't a rule yet; the lawyers haven't finished drafting the necessary verbiage. It is still a pious wish: Banks that enjoy government support should not be allowed to make risky bets (other than loans). Recognizing that the government will cover any really big losing bets, the Volcker Rule prescribes that they should make no such bets.

Many beachings in the pod of whales surely would bring on a new flood of funds to float them off the shoals. In 2008, the Treasury and the Federal Reserve not only bailed out banks that urgently needed a rescue, they also forced money on other banks that claimed to be healthy—to give cover to the really troubled banks by confusing the public.

Crisis Control

The officials who saved the whales in 2008 claim now that they also saved Western civilization. Fed Chairman Ben Bernanke told students at George Washington University in March, "The failure of AIG, in our estimation, would've been basically The End." He added, "We were quite concerned that if AIG went bankrupt, that we would not be able to control the crisis any further."

We can only hope that students and citizens will understand that this self-esteem is a form of hubris, for the Fed was never in control of the crisis. All it was doing was putting off the day of reckoning.

The Volcker Rule should be enforced, but in reverse. Banks can and will make risky bets, but they should not have access to government support—not even federal deposit insurance, which should cover only passbook savings accounts of small value.

The right rule would put pension funds, university endowments, money-market funds, and other enablers of financial whales on notice that their money is at unlimited risk.

Individuals and institutions should be free to put their money into any kind of casino that catches their fancy—banks, hedge funds or Ponzi schemes. Hiring French whales in London to trade derivatives should be as acceptable as hiring young math prodigies and eidetic card-counters to play poker in Las Vegas or taking a flutter on Facebook shares. But neither taxpayers nor pensioners nor the Treasury's creditors should be forced to have their money at risk in such vehicles.

Necessary Recessions

If banks can borrow and attract deposits and fund their proprietary trading with no recourse to federal funds, they can be free to assume whatever risks they please. If their investors and creditors conclude that they cannot assume those risks, that will force the banks to take appropriate action. They might even break themselves up into traders and deposit-takers.

The U.S. does not need a Glass-Steagall law to resegregate banking's golfers from its gamblers; it needs to end the government's market manipulation that creates a popular illusion of risk-free investing. And the U.S. needn't accept the perverse doctrine that some banks are too big to fail; it should make failure the authoritative financial regulator.

After fixing up the modern Volcker Rule, we can have a national conversation about the real Volcker Rule, the one that Paul A. Volcker used as Federal Reserve chairman in the early 1980s. It goes like this: Don't put off until tomorrow what you should do today.

Faced with high inflation, Volcker ended years of negative real interest rates by releasing markets to set interest rates according to perceptions of risk and monetary policy. The prime rate rose above 21% to get real rates into positive territory. The natural result was the deep recession of 1981-82, which featured unemployment over 10%. It deserved the title Great Recession, but Americans were not quite so hyperbolic 30 years ago. Volcker's rule marked the end of a 30-year bear market in bonds and the start of a 30-year bull market. The 10-year Treasury rate fell from about 15% to about 7% in six years.

Construction workers were hanging Volcker in effigy. Farmers watched inflated land values fall by as much as 60%, abetted by a brief attempt to expose agriculture to what the National Farmers' Union called "the anarchy of the marketplace." Foreclosures and forced sales by small farmers drew protests and charity rock concerts.

Today, however, Volcker is a sort of financial folk hero. It seems that his admirers have forgotten the necessary recession he forced to save the U.S. economy.

Today's politicians, however, won't accept the idea that recessions are necessary to wash away the debris from any era of reckless lending and excess money creation.

Credible Delay

Last week, at the Peterson Foundation's annual gloom fest, Treasury Secretary Timothy Geithner was the first of several national leaders to call for progress without change. He warned that doing anything about the national debt now runs the risk of pushing the economy back into recession. Most other speakers, both Republicans and Democrats, sang from the same hymnal, although Speaker John Boehner departed from the text to focus on spending cuts as the proper price for raising the debt ceiling.

Geithner did offer a crafty solution to the rising fear of rising debt: He would build a fiscal time bomb with a delayed-action fuse. He said Washington should devise a "credible" deficit-reduction and debt-control program, which would take effect after the U.S. economy has tallied a few quarters of healthy growth above an annual rate of 3%.

As St. Augustine prayed as a youth, "Lord, give me chastity and continence, but not yet."